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American Bar Association

ABA Section of Business Law


ABA Section of Business Law
Business Law Today
July/August 1999


Legal-ease

More on those parental guaranties

By Howard Darmstadter

You can e-mail Darmstadter at darmstadte@trvgroup.com.

In my preceding column, I addressed the trickiest problem in drafting a parent company’s guaranty of its subsidiary’s obligations — how to waive the suretyship defenses without waiving the subsidiary’s defenses. This column will address less-pressing drafting issues.

OK, let’s get to the question you’ve really been itching to ask, namely: How do you spell it? Is it "guaranty" or "guarantee"? The 1996 Restatement of the Law (Third) of Suretyship and Guaranty does not discuss spelling, but it uses "guaranty" for the noun throughout, with "guaranties" for the plural and "guarantee(s)" as the verb. In the Restatement, you draft a guaranty (or several guaranties, if business is good), but you guarantee an obligation.

Bryan Garner’s Dictionary of Modern Legal Usage states that the old distinction in British English between the noun form guaranty and the verb form guarantee has broken down both here and in Great Britain. Today,

[the noun] guarantee is the usual term, seen often, for example, in the context of consumer warranties or other assurances of quality or performance. Guaranty, in contrast, is now used primarily in financial and banking contexts in the sense of "a promise to answer for the debt of another." Guaranty is now rarely seen in nonlegal writing, whether in Great Britain or in the United States.

"Guaranty" may be the rarer bird these days, but it has the more precise legal sense that we are concerned with and should be preferred.

Now we can start drafting. Your first sentence should read something like "Daddy Corp. guarantees to the Worry Wart Whistle Works the obligations of Daddy’s subsidiary, Junior Corp., under the supply agreement dated April 1, 1999 between Junior and Worry Wart." Nifty. Mentioning that Junior is Daddy’s subsidiary isn’t necessary, but may help a reader understand the business and legal context.

Standard guaranties frequently expand this sentence to say something like "Daddy absolutely and unconditionally guarantees." (Sometimes they add irrevocably, which I’ll get to in a bit.) What do the extra words contribute?

I’ve seen "absolutely and unconditionally" used in front of "indemnifies," "promises to pay" and a number of other verbs. Garner doesn’t have an entry for either word, and Black’s doesn’t give the words any particular "legal" meaning. In most legal contexts, the words "absolutely and unconditionally" have no other function than to produce that tone of high solemnity deemed appropriate for a legal obligation. You can read them as synonymous with "Yea, verily."

But — surprise! — "absolutely and unconditionally" actually mean something (maybe a couple of things) when used in a guaranty, though I doubt if you could tell me what. (If you think they might be adequate to waive suretyship defenses, forget it. They don’t. Restatement § 48, Comment d.)

An "absolute guaranty" is one that is effective without Worry Wart’s having to notify Daddy of its acceptance of the guaranty. Restatement § 8, Comment a. This may be desirable, but I wouldn’t want to do it with a word as mysterious as "absolute." Better just to say "This guaranty will be effective without notice of acceptance by Worry Wart." No one is likely to be blindsided by that sentence.

In many jurisdictions, an "absolute" or "unconditional" guaranty also means a guaranty that can be enforced by Worry Wart immediately upon Junior’s default; Worry Wart won’t have to indulge in any niggling legal formalities, such as suing Junior, but can go straight to Daddy. This contrasts with a guaranty of collection , which Worry Wart can only enforce against Daddy after an execution of judgment against Junior is returned unsatisfied, or if Junior is bankrupt, cannot be served or if it is otherwise apparent that payment cannot be obtained from Junior (Restatement § 15(b)).

The Restatement doesn’t have any nomenclature for an absolute (or unconditional) guaranty, probably because every guaranty is enforceable against the parent immediately on default of the subsidiary unless the guaranty says otherwise. In many jurisdictions, however, such a guaranty is called a guaranty of payment. It’s not necessary to state that a guaranty is a guaranty of payment, but if you want to hammer the point, don’t say that the guaranty is "absolute and unconditional." Say "This guaranty is a guaranty of payment and not of collection." Phrases like "absolute and unconditional" are the bane of legal drafting — they generally mean nothing, except when they mean something unexpected.

A guaranty can, and often does, contemplate a continuing series of obligations. For example, the agreement between Worry Wart and Junior may look forward to a whole series of whistle shipments and payments. A guaranty that covers these future obligations is called a continuing guaranty (Restatement §§ 15(e), 16). If the context doesn’t make it clear, your guaranty should say, "This guaranty is a continuing guaranty."

Under several legal theories (none of which needs trouble us here), Daddy can terminate its guaranty of Junior’s future obligations by notifying Worry Wart (Restatement § 16). Worry Wart can then decide if it wants to continue to deal with Junior on an unguaranteed basis. Daddy’s termination will not, however, terminate its guaranty of any obligations Junior incurred prior to Daddy’s notifying Worry Wart of the termination.

Because Daddy’s obligations under a continuing guaranty will only be terminable as to Junior’s future obligations, you do not need to style your guaranty as "irrevocable." If the guaranty is continuing, calling it "irrevocable" might cut off Daddy’s right to terminate its obligations as to Junior’s future whistle purchases. That is seldom a good idea. It makes sense that Daddy may want to cut off its obligations under its guaranty, and the notice requirement means that Worry Wart will not be caught unawares. (If the whistle-supply agreement has been properly drafted, it will enable Worry Wart to terminate if the guaranty is revoked.) The guaranty should, however, provide for a short period between Daddy’s notice of termination and its effectiveness, so that Worry Wart will have adequate time to react.

Guaranties often provide that Daddy’s obligations will be reinstated if Worry Wart has to return a payment made by Junior, as might happen if Junior’s payment is held to be a voidable preference. A good thought, but hardly novel. Basic guaranty law requires reinstatement of the obligation under these circumstances (Restatement § 70), so there’s no need to spell it out in the guaranty.

Guaranties frequently have dollar and time limits. For example, Daddy’s liability under the guaranty might be capped at $1 million and limited to whistles ordered before Oct. 31, 1999. There’s no legal problem with including such limits in a guaranty. Whether you have such limits will depend on the transaction and the parties. A guaranty with such limits places a monitoring burden on Worry Wart; without them, the monitoring burden is on Daddy. If the Worry Wart-Junior transaction has dollar and time limits, Worry Wart will already have the monitoring burden, so mirroring those limits in the guaranty makes sense.

If the underlying transaction does not have a dollar limit or a fixed termination date, it may make more sense to place the monitoring burden on Daddy. Generally, Daddy might be expected to know about Junior’s activities. However, if Daddy’s headquarters are many leagues removed from Junior’s, and if Daddy has many other subsidiaries in diverse businesses, Daddy may monitor Junior less closely and may try to put some of the monitoring burden on Worry Wart.

Under the law of guaranty, if Daddy pays a limited guaranty obligation in full, Daddy will, to the extent of its payment, be subrogated to Worry Wart’s claim against Junior. But if Daddy pursues its claim, it is likely to be competing against Worry Wart. Accordingly, the guaranty may require Daddy to delay pursuing subrogation claims against Junior until Worry Wart has been fully satisfied. Worry Wart may also want Daddy to subordinate its other claims against Junior to Worry Wart’s claims. Whatever the equity of such provisions in a guaranty by an unrelated party, they seem fair enough in the context of a parent guaranty.

Finally, since (you probably saw this one coming) a guaranty is a contract, you will probably want some relevant contractual boilerplate. A choice-of-law section is usually desirable, as is a clause against oral amendments. Note that while the guaranty will likely only be signed by Daddy, you will usually want any amendments signed by both Daddy and Worry Wart.

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